Searching for Culprits

The Angelides commission is geared up to find wrongdoers. We might all get poorer regulation as a result.

The Angelides commission is a bipartisan enquiry established by the U.S. Congress into the causes of the 2008 financial crisis. Many expect its findings to set the tone for financial market regulation for decades.

With global financial market integration now demonstrated so conclusively, the findings of the commission will probably also influence financial industry regulation worldwide.

At the extremes, there are two schools of thought about how the crisis began. One school believes that it arose from bankers behaving badly. This view dominates thinking among U.S. political leaders.

At the other end of the spectrum are those who believe that the crisis arose from a set of macroeconomic conditions promoted by a Federal Reserve taking risks with asset prices for more than a decade before the bubble it created burst. This view is more prevalent among investment strategists.

No doubt, reality lies somewhere in between in an extraordinarily complex mix of policies, politics, greed and reaction to legitimate market incentives.

A taste of the commission's thinking could be seen in the employment histories of the first senior staff appointed by the commission.

Appointment 1. Former leader of the 300 attorneys in the affirmative litigation area of the office of attorney general in California.

Appointment 2. Handled enforcement matters at the Federal Home Loan Bank and served in the private sector with an emphasis on banking litigation.

Appointment 3. A former federal law enforcement professional specializing in white collar crime and corporate financial integrity.

Appointment 4. Nationally recognized for his ability to investigate and prosecute financial corruption.

Appointment 5. A lawyer with a background in complex financial and securities litigation.

Appointment 6. A lawyer at leading firms with a background in complex securities cases.

Such a stark emphasis on investigational and enforcement skills signals that the committee is unlikely to react favourably to arguments about markets and monetary conditions being the primary driver of the financial crisis.

Lloyd Blankfein, the chairman of Goldman Sachs and one of the chief villains in the eyes of some, put the macroeconomic and sociological aspects of the crisis at the center of his explanation of why the crisis evolved when he gave evidence before the commission recently. One exchange between the commissioners and Blankfein was illustrative of the gulf between the two.

Blankfein had been at pains to have the commission members understand the role of market making in which Goldman Sachs, acting as principle, facilitated decisions by institutional investors to buy or sell securities.

Angelides was highly critical of the idea that Goldman Sachs would sell a security to an institution and make a profit if the price of the security subsequently fell in value. While Angelides believed this was wrong, Blankfein believed it was a service investors wanted ans an important contributor to market efficiency.

Indeed, taken to its logical conclusion, the Angelides view would mean that no investor could sell a security if he believed that its value was subsequently going to fall. That would be a radically different world than the one we live in now.

When chairman Angelides pushed Blankfein on whether he would look back on some of the financings undertaken by Goldman Sachs as negligent or improper, Blankfein observed in response that "those were very typical behaviours in the context in which we were in".

Blankfein described the context in the following way in another response to commission questioning: "The markets got a lot more competitive. There was a sense that the world had a lot of liquidity so the commodity of money got less scarce and people paid less attention to it and as a consequence people were lending for transactions.... that had more multiples of debt for the equity and the covenants became more and more lax."

He was aware at the time that lending conditions had become less stringent but "we talked ourselves into a place of complacency". He recalled the rationalization in this way: "The world is getting wealthier. Technology has done things. Things are more efficient. There is no inflation. These businesses are going to do well."

There was no sense that any of this satisfied Angelides or his fellow commissioners. Indeed, the contrary was evident.

A bias toward finding wrongdoers implies future structures which will constrain financial product development and market making. Unfortunately, this would be akin to compelling use of covered wagons because of the large number of road deaths from people using motor vehicles.The world will be disadvantaged if the recommendations of the commission were biased in this direction simply because the alternatives had been excluded before their benefits had been assessed.

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